nonprofit operating reserves

It’s that time of year when donors make key decisions about their end of year giving. But a recent post on the Social Earth blog advising donors about questions they should ask nonprofits perpetuates thinking that actually hurts, rather than helps the nonprofit sector. The author, Tarini Chandak, asks “How do you know where your charitable dollars are going? Are they going to the cause you want to support or are they going to administrative and fundraising expenses?” In reinforcing old, and destructive binary thinking about program vs. overhead expenses, Tarini is doing nonprofits and their donors a real disservice.

Tarini lists 4 key questions she thinks every donor should ask of the nonprofits they consider donating to:

As various charities vie for your charitable donations, there are many questions you can ask them directly, including:

How much goes to the cause? How high are their expenses?

How efficient is their fundraising? What is their cost-per-fundraised-dollar ratio?

Is the charity run properly? How efficient and effective is their human capital? Management team?

Do they even need your money? Will your money just be lying around in their reserve?

I think questions #2 and #3 are excellent, but questions #1 and #4 perpetuate thinking that holds the nonprofit sector back.

Let’s start with Question #1: “How much goes to the cause? How high are their expenses?” As I’ve written before, the distinction between program (or “cause”) and administrative expenses is meaningless at best, and destructive at worst. If a nonprofit organization is creating change, then everything they do is in support of that change. How can a program run if there is no financial engine (fundraising) to fund it? If there is no building or space to house it? If there is no financial management or regular audits? If there is no regular evaluation of whether the program is making a difference? How can you possibly separate “program” from “overhead?” We must move beyond this distinction and encourage nonprofits to raise (and donors to give) more capacity capital, or the money that nonprofits so desperately need to create effective and efficient organizations.

Tarini’s Question #4 “Do they even need your money? Will your money just be lying around in their reserve?” is equally troublesome because it reinforces the backward notion that nonprofits should not have a reserve fund. As I (and others) have written before, we have to get away from the nonprofit taboo that operating reserves are wrong. Nonprofits cannot plan for the future, have a sustainable financial model, experiment with program changes, take risks, or any of the other things that are absolutely necessary to creating social change, without some operating reserves. If nonprofits are continually forced to go month to month without any cushion they will never emerge as strong, sustainable organizations capable of creating lasting change.

We must move away from thinking that encourages nonprofits to scrape by without the tools and infrastructure they desperately need. We must stop measuring nonprofit performance with meaningless financial metrics and instead evaluate nonprofits on their ability to deliver change. If a nonprofit is creating real change, does the minutia of how they spend money really matter?

There’s a new blog I discovered recently that I’ve grown to really like. Against the Grain, written by Rick Moyers of the Eugene and Agnes E. Meyer Foundation, is about challenging nonprofit boards to be more effective. Recently Rick has been writing about the need for nonprofit operating reserves. Operating reserves are simply an amount of set aside money that a nonprofit has accessible in times of crisis, budget shortfall, etc. In Rick’s most recent post on the topic, he explains how nonprofits can go about building operating reserves. And to him, it’s quite simple. But I would argue that Rick ignores a pretty ingrained nonprofit financial taboo against running a surplus.

Rick argues that creating operating reserves is fairly easy: “The most reliable way to build reserves is by operating at a modest surplus (bringing in more money than you spend) consistently over time.” And the way he suggests doing this is to have “the fiscal discipline to make hard choices and the ability to resist putting all “extra” money immediately into expanded programs and services.”

But Rick ignores the fact that in much of the sector it is unseemly for a nonprofit to operate a surplus. I cannot tell you how many times I have seen nonprofit leaders massage the budget projections accompanying a funding proposal in order to show break even or a loss in a given year. It is somehow inappropriate to show funders that the organization is too far into the black. And how many board meetings have been lost to a discussion about why money is sitting in a bank account instead of serving more people? Board members become quite uncomfortable when “too much” money is sitting idle. Because the question is always: if money exists, why isn’t it being plowed into more programs?

Indeed, it seems the majority of nonprofit organizations don’t enjoy much of a surplus. The 2011 Nonprofit Sector Survey conducted by the Nonprofit Finance Fund found that 60% of nonprofits reporting had less than 4 months of expenses as operating reserves and 28% of nonprofits had less than 1 month of reserves, which is essentially breakeven. Rick found similar results in a survey his foundation conducted in the Washington area.

But money sitting in a bank account serves a very real purpose for a nonprofit. It means the organization doesn’t live hand to mouth, no longer continually puts out fires, and stops expending energy on just keeping the doors open. Operating reserves allow an organization to evolve to the next level where they can think strategically, take some risks, streamline their business model, innovate their solution, and weather economic uncertainty all in the name of delivering bigger, better social impact.

So the nonprofit sector must get over the surplus taboo. It’s ok to run a surplus, in fact, a surplus means that the organization is better positioned to deliver more impact down the road. The key to financial sustainability, and ultimately significant social impact, is strategic financial management. And operating reserves are a first step to getting there.